The US-China Trade War: Next Weeks Shanghai Meeting is a Tiny Glimmer of Hope

Since the beginning of US-China trade negotiations, this blog has been relentlessly negative on US-China relations, which we usually describe as being in a “straight line decline.” In October, 2018, in China, the United States and the New Normal, we started calling the bad relations between China and the United States the “New Normal” and in that same month, we titled a post Would the Last Company Manufacturing in China Please Turn Off the Lights that mentioned how “it does sometimes feel as though within three years nobody will be making widgets in China anymore.”

In April of this year, the Wall Street Journal quoted Dan Harris from this blog (and my law firm) in a cover story, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, saying the following:

“There is no way any deal between China and the U.S. will cause everyone on both sides to say, ‘We were just kidding,’” said Dan Harris, managing partner at Harris Bricken, a law firm that specializes in investment with China. “The tariffs and the arrests and the threats and the heightened risk have impacted companies and that will not go away.”

Then on May 4, 2019, (one day before President Trump’s May 5 tariff tweet that changed everything) we wrote The US-China Trade War: Winter is Coming on how no matter what happens in the US-China trade war, things will NOT revert back to the way they had been for foreign companies:

The above is but an introduction to what we see as China’s diminished future for foreign companies. Since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending. Vice-President Pence’s speech on China earlier this week has only reinforced for me that the trade war between China and the US will not be ending any time soon, if ever. The New York Times has called that speech the Portent of a New Cold War between the United States and China and China’s own Global Times wrote an article entitled, Pence speech shows Washington’s tougher policy on China. Don’t blame us. We are just the messengers. Things are getting very tough between China and the United States right now and the trade war is just a symptom of that, not the disease.

The United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

So yes, the above is why we will continue to write about what North American and Latin American and European and Australian businesses should be doing to deal with the new normal regarding China. We are writing these things because we value our credibility and because we presume our readers value our no-holds barred advice — threatening emails or not.

We have been writing about China’s diminished future for foreign companies since pretty much the inception of the US-China trade war because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not (and do not) see China changing on these things, we did not (and do not) see the trade war ending.

But the above posts and nearly all of the other posts on China trade and China relations with the West and on everything Huawei (See The Huawei Indictments are the New Normal) were written by either Dan Harris or Steve Dickinson, both of whom are international lawyers and part of what we in my law firm call “The International Law Team.”

The above is my long introduction to this post (which is also long) because I am writing this from a different perspective than Dan and Steve because the bulk of my work is in International Trade. I am an international trade lawyer and a part of my law firm’s international trade law team.  I therefore necessarily see the U.S.-China tiff from more of a trade law perspective and less of a political perspective than Dan and Steve and that is my slant of this post on the eve of renewed trade negotiations between the United States and China.

United States Trade Representative Robert Lighthizer and United States Secretary of the Treasury Steven Mnuchin are heading to Shanghai next week for trade talks with China. The choice of Shanghai is interesting. One analyst suggested China chose Shanghai as the venue to send the message that “trade should be trade, and politics should be politics”. Even Mnuchin invoked the spirit of the 1972 Shanghai Communiqué, which paved the way for rapprochement between the U.S. and China — and ironically the current trade mess in which the two countries find themselves. Perhaps the hosts are thinking of a different kind of optics. There is arguably no image more associated worldwide with China’s economic miracle than Shanghai’s Lujiazui skyline. Just look up “china economic miracle” on Google Images for confirmation. It is hard to reconcile the portrait of China as an economic villain with the Pearl of the Orient’s vibrancy.

Before delving into the prospects for the upcoming talks, it is worth taking a step back and remembering how we got to this point. As mentioned above, the Shanghai Communiqué Mnuchin celebrated set in motion a process that would over time entangle the Chinese economy with those of the United States and other nations in an unprecedented way. Though Cold War realities were initially foremost in America’s thinking, China policy soon became undergirded with the idea that increased engagement with the United States and  it democratic, free-market allies would inexorably lead China down their same path.

There was certainly much change, but mostly only to the extent that it allowed China to become an export powerhouse. One can imagine the thrill felt by foreign executives as they saw the first cases of Coke cross the Shenzhen River into Mainland China in 1979, representing a symbolic first step towards the final realization of the long-standing Western dream of opening up China. Yet 30 years later, in some fundamental ways little has changed for foreign business. Sure, it has been a relatively smooth ride for the KFCs, Colgates and Nikes of the world, who contribute mightily to China’s state coffers. But for many foreign businesses, their China experience has been mostly a negative one, especially in the last year or so. As a longtime China expat, I heard so many tales of foreign business woe that I became jaded. Business partners colluding with local authorities to edge out foreign investors. Rampant counterfeiting and infringement of foreign brands. Continued restrictions on market access. Capricious immigration policies. China nightmares remain unabated despite repeated Chinese government assurances of coming improvements. Mr. China remains as much of a cautionary tale today.

Ultimately, the Chinese leadership viewed and continues to view Reform and Opening as a transactional mechanism. Reform and Opening were never China’s objectives; continuity of Party rule has always been. This is why China continues to pick and choose when it comes to reform, in a way that has led to a collision with the United States and the EU.  By the time the 2016 U.S. presidential campaign got underway, it was clear to most  that China would not follow the path of South Korea and Taiwan towards democracy, negating the one hope that secured for China so much patience over the years. In this environment, Donald Trump decided it was time to bring China’s bad behavior to the forefront.

The current trade war’s first salvo was fired in March 2018, when President Trump directed the USTR to propose a list of products to be subjected to tariffs, in response to the findings of the USTR Section 301 investigation launched in August 2017. Ultimately 1,300 types of products were listed.

China retaliated with tariffs on 128 U.S. products and asked the WTO for consultations on the U.S. tariffs. After a visit to Washington by Vice Premier Liu He, China’s point man on trade, the two countries announced there “was a consensus on taking effective measures to substantially reduce the United States trade deficit in goods with China.” This led Secretary Mnuchin to declare the trade war was “on hold.” However, and perhaps reflecting disagreements within the Trump team, shortly thereafter 25% tariffs on $50 billion worth of imports were announced. These tariffs went into effect on June 6 ($34 billion) and August 8 ($16 billion).  China retaliated in kind.

In September 2018, the U.S. announced 10% tariffs on $200 billion worth of Chinese products, which were raised to 25% on May 5, 2019. China’s expected retaliation came on June 1, in the form on tariffs on $60 billion worth of U.S. imports.

Presidents Trump and Xi met during the G-20 summit in Osaka, Japan and announced a truce. The upcoming talks in Shanghai are the first high-level encounter since that Osaka meeting.

The smart money is on keeping expectations low. As an analyst quoted by the SCMP noted that the “talks will only result in a small step.” Still, even a small step would be a welcome respite from the spiral of escalation we have seen over the past year. The key question is, what exactly might that small step be?

A rollback in tariffs is one option. China has previously demanded all tariffs be eliminated before a deal can be reached. This is surely a no-starter for the Trump team, which in fact would like to keep some tariffs in place even after a deal is made. However, having slapped tariffs on $250 billion worth of Chinese imports, the U.S. side has plenty of room to maneuver, allowing it to simultaneously reduce the tariff burden considerably, while still leaving meaningful tariffs in place.

On the issue of Huawei, the introduction of a bipartisan bill in Congress that would lock the Shenzhen-based telco into the Commerce Department’s blacklist complicates matters. Paradoxically, however, the Democrats jump onto the Huawei bandwagon could help the Trump negotiators in two ways. First, it moves the goalposts in a way that allows the administration to do a lot without accomplishing anything when it comes to Huawei. Second, Lighthizer and Mnuchin can now point to concrete evidence that a Democratic victory in 2020 will not give China any respite from American wrath. Better the devil you know….

As for China’s side of the bargain, hopes of placating the U.S. with purchases of agricultural goods seems to have faded, as China now seems to realize that no amount of sorghum will get the U.S. to ease up on its core demands. It is critical to remember that the Section 301 investigation that provided the legal basis for the tariffs concerned Chinese government practices “related to technology transfer, intellectual property, and innovation”. In the absence of meaningful Chinese concessions on these areas, it is hard to see the U.S. budging on either tariffs or Huawei.

The Section 301 investigation report provides a clear picture of what the U.S. would like to see happen regarding these critical areas. Last month, China announced it will open up new sectors to foreign investment and it may offer further liberalization.

As difficult as it may be for some Dragon Slayers to accept, not every single line of Chinese jurisprudence has been drafted with a nefarious, China-first agenda in mind. For instance, when Article 43(1) of China’s Joint Venture Regulations call for “fair and reasonable” fees for the use of technology, it is reflecting the basic principle that, “In civil activities, the principles of voluntariness, fairness, making compensation for equal value, honesty and credibility shall be observed” (Art. 4, General Principles of Civil Law). Meanwhile, “Vaguely worded provisions and uncertainty about the applicable rules” are a hallmark of Chinese legislation, and serve as powerful levers with implications that go far beyond foreign direct investment (FDI).

One intriguing, if unlikely, possibility would be the introduction of more specific investment terms into a bilateral treaty (such as the income tax treaty or the consular convention). This could include language that puts Chinese investment into the U.S. under additional scrutiny. It could also provide for special procedures to allow companies like Huawei to obtain technology while providing certain safeguards. This approach would allow the Chinese to save face as far as its own legislation is concerned, while pleasing the Americans (who, given the current tenor in Washington, are unlikely to care too much about protestations from Brussels or Ottawa regarding this side deal).

Speaking of unconventional wisdom, the possibility of non-trade elements playing a role in a deal cannot be discarded. In the lead-up to the talks, Secretary Pompeo called China’s treatment of Uighurs in Xinjiang “the stain of the century,” while Vice President Pence tweeted a condemnation of China’s record on religious freedom. And there is always Hong Kong. This simultaneous push on trade and human rights is consistent with the “whole of government” approach against China called for in the—ironically-named—John S. McCain National Defense Authorization Act for Fiscal Year 2019. Admittedly, it is hard to see where China can budge, especially in the kind of public way the Trump team needs to be able to claim some kind of victory. That said, if it gives him some oxygen on tariffs and Huawei, President Xi might be willing to pull something out of his hat on North Korea or even the South China Sea.

So though must of my law firm’s international lawyers are beset with a severe case of what they hae taken to calling “China promise fatigue syndrome,” I am marginally more optimistic about the US and China at least reaching some sort of deal to stop the decline in trade relations. Not so optimistic that I am not also telling our clients to — if at all possible — move their manufacturing out of China, but optimistic enough to believe that both China and the U.S. might get caught up in the Shanghai spirit just enough next week to keep things moving forward. But not enough not to advocate that if your products are subject to U.S. tariffs you should get going on your China tariff exclusion requests now.

We will be discussing the practical aspects of Chinese law and how it impacts business there. We will be telling you what works and what does not and what you as a businessperson can do to use the law to your advantage. Our aim is to assist businesses already in China or planning to go into China, not to break new ground in legal theory or policy.